For years, Prime Minister Justin Trudeau promised to remove the veil of prohibition on recreational marijuana in Canada. On Oct. 17, following months of debate in the Senate, and additional months spent getting the proper infrastructure in place, Canada became the first industrialized country in the world to legalize adult-use weed, and only the second country in the world, other than Uruguay, to do so.
This monumental shift in cannabis policy in our neighbor to the north is paving the way for billions of dollars in annual added sales, as well as creating plenty of new jobs and tax revenue for the Canadian federal government.
Well, that didn't take long
However, this new industry isn't going to kick off without a hitch. As practically everyone saw coming, except for apparently the Canadian federal government and individual provinces, Canada is running into some early-stage weed supply shortages.
On the first day of legalization, the Quebec branch in charge of managing cannabis sales, the SDQC, reported more than 12,500 in-store transactions, as well as approximately 30,000 online orders. This was far and away above the SDQC's expectations for first-day sales. As reported by USA Today, some products in Quebec have already been removed from the online store because their supply has been exhausted after only four days.
Said the SDQC in a statement, "Given the craze created by the legalization of cannabis and the scarcity of product across Canada, the SQDC expects significant short-term supply challenges for the branches." The SQDC is tasked with running the dispensaries licensed to sell marijuana in Quebec.
Of course, Quebec is far from alone. Manitoba Liquor and Lotteries also witnessed a surge in demand that was above and beyond its expectations. Rather than a short-term shortage, it has warned that cannabis shortages could last for months. Rolling Stone reports that one Winnipeg location sold out of its entire stock of product just hours after opening.
Three reasons cannabis shortages were to be expected
Should this really be a surprise to anyone? Absolutely not, and for three good reasons.
1. Health Canada has been overwhelmed by cultivation and sales applications
First, Health Canada has been absolutely bogged down by cultivation and sales applications, which has constrained the number of licensed growers, and the capacity those growers have, to produce cannabis. Back in late May, Marijuana Business Daily reported that while cultivation license applications soared through the first four months of 2018 on a year-over-year basis, the approval process remained at a crawl for Health Canada. With more than 500 cultivation applications filed, the average wait time for approval has been six months to a few years.
Making matters worse, getting approval to cultivate cannabis represents only half the task. Once a grower gets the go-ahead to plant and harvest their crop, they'll need to get approval from Health Canada to actually sell it. Per Marijuana Business Daily, the average length of time between filing for a sales permit and gaining approval was 341 days -- pretty much three weeks shy of a full year. Thus, the entire application process from start to finish could take the average grower 18 to 36 months, which has greatly constrained market supply.
2. Growers are years away from reaching full capacity
Even if Health Canada were to churn out cultivation and sales licenses quicker than we could blink, Canadian growers aren't going to be anywhere near peak production capacity for a few more years.
According to a report issued by Health Canada, domestic demand is expected to reach roughly 1 million kilograms per year, with other Canadian provinces predicting closer to 800,000 kilograms in annual domestic demand. Regardless of which entity is closer to being correct, growers aren't anywhere near these figures.
For example, the four biggest growers by projected peak yield are Aurora Cannabis (ACB -1.73%), Canopy Growth Corp. (CGC 0.26%), Aphria (NASDAQOTH: APHQF), and The Green Organic Dutchman (TGOD.F -2.08%). Company and/or author-estimated annual peak production figures for these four growers are north of 600,000 kilograms, around 500,000 kilograms, 255,000 kilograms, and 195,000 kilograms, respectively. That's roughly 1.55 million kilograms from just four producers.
But where are we now? Aurora Cannabis announced in its most recent quarterly operating results that it's generating 45,000 kilograms on an annual run rate as of September, with an aim for 100,000 kilograms by the end of calendar 2018. Canopy Growth, which doesn't provide peak estimates, harvested around 9,700 kilograms in the first quarter, putting it on an extrapolated annual run rate of about 40,000 kilograms. Aphria announced during its latest report that it's producing about 35,000 kilograms annually at the moment. And The Green Organic Dutchman isn't even expecting its first sale until sometime during the first half of 2019. That's 120,000 kilograms of combined run-rate annual production at the moment from a group of four growers expected to account for more than 10 times that amount at peak production.
Even with Aurora, Canopy, and Aphria setting aside dried flower and oils for inventory purposes, it was never going to be enough.
3. We've seen this happen before
Finally, the writing was on the wall for anyone who's paid attention to recreational legalizations in the United States. In July 2017, less than a year after voting to legalize adult-use marijuana, Nevada opened its dispensaries for business. However, supply issues, coupled with logistics problems, caused Nevada to run into a major cannabis shortage just 10 days after opening its doors. This has been a pretty common theme throughout the U.S. when a state legalizes recreational pot.
It's going to take quite a bit of time in Canada before growers can meet demand and the initial euphoria wears off. Though I still strongly believe long-term oversupply is a bigger concern, short-term supply issues have the potential to constrain sales growth and disappoint both consumers and investors.